Stockton’s Moral Deficit: A creditor argues that the California city’s bankruptcy is a sham.
Suppose you go on a spending spree, purchasing luxury items on credit such as a vacation home and new cars. Part of you knows the good times won’t last forever. Nevertheless, you decide to buy things you can’t afford, convincing yourself that you need and deserve them. In the process, you make some investments that don’t pan out. When ends don’t meet, you go to the bank and take out loans to pay off your older balances. Now deep in a financial hole, you hit upon a plan to climb out: simply default on your new loans by declaring bankruptcy and propose that the court let you do so without selling off most of those new toys you bought.
This is essentially the path taken over the past decade by the northern California city of Stockton, which filed for Chapter 9 bankruptcy protection last June. City officials ramped up spending on new public buildings and downtown entertainment venues and committed to lifetime medical care for city workers. The city structured its public-employee pensions in a way that guaranteed multimillion-dollar retirements for police officers and firefighters after a few decades on the job. California’s second-most-dangerous city, Stockton has been forced to lay off scores of public-safety employees to help pay for the profligacy.
When the city couldn’t meet its pension obligations in 2007, officials turned to lenders, including Lehman Brothers, and borrowed $125 million in pension-obligation bonds, the municipal-finance equivalent of taking out a new loan to pay ongoing mortgage expenses. The bonds bought the city some time, but the housing-market collapse dealt a devastating blow to Stockton’s rickety finances. Five years on, city property-tax revenues haven’t rebounded, and the inland port city in the agricultural San Joaquin Valley remains one of the most troubled real-estate markets in the country.
Stockton’s bankruptcy plan involves stiffing many of the creditors who provided the pension-obligation bonds in the first place. It’s tough to sympathize with any lender that would give pension-obligation bonds to a city as poorly run as Stockton. But it’s even tougher to disagree with a recent bankruptcy court filing by Assured Guaranty, the insurer underwriting those bonds. The company claims that Stockton is not really insolvent and that its bankruptcy filing, therefore, is a sham.